Business Outlook

Slashing the Deficit without Massive Tax Hikes

For all the political theater surrounding the newly appointed deficit commission, there are some straightforward steps it could take to change the alarming U.S. debt dynamics. The panel is supposed to recommend ways to narrow the gap to 3% of gross domestic product by 2015, down from this year's 10.6%, and improve the fiscal outlook by tackling entitlement programs. Here's how it could be done:

Start with Social Security. Now on track to become insolvent by 2037, the program with modest changes could contribute $60 billion in annual savings by 2014. A quarter of the $5.3 trillion Social Security shortfall over the next 75 years could be made up simply by pegging annual cost-of-living adjustments made to retirees' pensions to an index many economists believe measures inflation more accurately than the one Washington uses. Adopting the so-called chained consumer price index—which takes into account people's tendency to substitute similar but cheaper products when prices rise—would save taxpayers billions.

People live longer now. Recognizing that, raising the retirement age would make up another quarter of the gap. The full Social Security retirement age is already rising to 67 for those born after 1959. Save big by including those born after 1958 and pushing the eligibility back by a month every other year. The retirement age still wouldn't reach 69 until long after today's workers retire.

The remaining shortfall could be gained from a tiny boost in the Social Security tax—four-tenths of a percent, split between workers and employers—and by lifting the cap on wages subject to the levy to $198,000 from today's $106,800.

As for the deficit in 2015, if the rosy economic assumptions in the Obama Administration budget are replaced with more realistic ones, $423 billion would have to be slashed from the White House's spending plan. The budget already counts on tapping the wealthy by allowing Bush-era tax cuts to expire for families earning more than $250,000 per year, raising current estate and capital gains taxes, and hitting up banks to recover the cost of the financial bailout. So the $423 billion needs to be cut elsewhere.

Again, an updated inflation index could be used. By switching all government programs, including federal pensions, and the tax code to the chained CPI, we'd save an additional $10 billion annually above the $60 billion gained from the Social Security fix.

Now comes the politically hard part: limiting tax breaks dear to the middle class. End the deduction for state and local taxes. Cap the portion of home loans eligible for mortgage interest deduction at $500,000. Curb charitable giving deductions to cover only those above 2% of income. Limit the exclusion from taxes for employer-provided health coverage to $1,440 a month for a family plan. Plus, end the tax exclusion for employer-paid life insurance. In all, that would raise $161 billion.

A carbon tax similar to Obama's cap-and-trade emissions plan would raise $50 billion, even if half the revenue went to tax credits for low- and moderate-income families and aid to coal-mining towns and other affected communities. And an excise tax on sugar-sweetened drinks of a penny per ounce would raise $20 billion.

The President wants a three-year freeze on domestic discretionary spending. It has already been swelled by stimulus outlays, and surely by 2015 the recession will have passed. So reduce domestic discretionary spending to its inflation-adjusted, pre-stimulus level of 2008 for $43 billion in savings. A 20% drop in farm subsidies yields $3 billion more. And canceling just three big weapons programs—the Joint Strike Fighter, the Future Combat Systems, and the Maritime Prepositioning Force—would save $9.3 billion. The remaining $67 billion could be met by cutting an additional 5.4% of overall discretionary spending (11.9% if defense is excluded) or raising income tax rates by 1.4 percentage points.

Obviously, there's plenty not to like here. The point is that it's not impossible to fix the deficit. It just requires sacrifice.